Q. In the context of India, which of the following factors is/are contributor/ contributors to reducing the risk of a currency crisis?

  1. The foreign currency earnings of India’s IT sector
  2. Increasing the government expenditure
  3. Remittances from Indians abroad

Select the correct answer using the code given below:

  • 1 only
  • 1 and 3 only
  • 2 only
  • 1, 2 and 3

Answer: (b) 1 and 3 only

Notes:
  • A currency crisis involves the sudden and steep decline in the value of a nation’s currency, which causes negative ripple effects throughout the economy.
  • Central banks and governments can intervene to help stabilize a currency by selling off reserves of foreign currency or gold, or by intervening in the forex markets.
  • This decline in value negatively affects an economy by creating instabilities in exchange rates, meaning that one unit of a certain currency no longer buys as much as it used to in another currency.
  • Foreign currency earnings and Remittances contribute to the strengthening of the rupee.
    • Foreign currency earnings of India’s IT sector will lead to an increase in the supply of foreign currencies, and this further increases the forex reserves. Therefore, more supply and less demand for foreign currency relative to the Indian rupee helps in reducing the risk of currency crisis.
    • Remittance is the sum of money (in foreign currency), sent from abroad or overseas to the home country. Remittance is the major source of cash inflow into any country. With the inflow of foreign currency, forex reserves again increased which further reduced currency crisis. India is the largest remittance-receiving country in the world.
  • Increasing government Expenditure will have no effect on the value of the currency. Currency crisis can be reduced by manipulating the demand and supply of currency in the foreign exchange market.
Causes of Currency Crisis
  • Heavy fluctuations in the stock market and foreign exchange market.
  • Rise in inflation and unemployment.
  • The adverse affecting changes in monetary policy.
  • The downturn of the economy.
  • Heavy reliance on foreign investment.
  • Clashes between the two countries can cause war situations.